Accounting Information For Everyone

Vat Taxation Methods

A value-added tax (VAT) is a tax on the value added at each stage of Sale of Goods. A VAT can be computed under one of three methods:

1) The credit invoice method or Invoice Method (Mostly Used)

2) The subtraction method, or

3) The addition method.

1) Credit invoice method:

Stage of production:

Sales

VAT

VAT on purchases

Net VAT

Raw materials

Rs 100 x 10%

Rs 10

(Rs 0)

Rs10

1st processor

Rs 120 x 10%

Rs 12

(Rs 10)

Rs 2

Distributor

Rs 140 x 10%

Rs 14

(Rs12)

Rs 2

Retailer

Rs 180 x 10%

Rs 18*

(Rs 14)

Rs 4

Total

Rs 18

* There would be no need to separately state the VAT on the invoice because the customer would not be entitled to a credit for the VAT paid.

Under the credit invoice system, a company’s recordkeeping is fairly straightforward because it will use a procedure whereby it keeps track of sales invoices showing VAT collected and purchase invoices from other businesses showing VAT paid.

2) Subtraction method:

Stage of production:

Sales

Less purchases

Calculation

VAT

Raw materials

Rs100

Rs 0

Rs 100 x 10%

Rs 10

1st processor

Rs 120

Rs 100*

Rs 20 x 10%

Rs 2

Distributor

Rs 140

Rs 120*

Rs 20 x 10%

Rs 2

Retailer

Rs 180

Rs 140*

Rs 40 x 10%

Rs 4

Total

Rs 18

3) Addition method VAT:For this type of VAT, the tax rate is applied to the total of the taxpayer’s inputs that were not purchased from other businesses, such as employee wages, interest and owner profit (that is, the value added by the business). This should result in the same tax as with the subtraction method. For example, if the retailer total sales of Rs.18,000 less cost of materials purchased of Rs 14,000 less wages of Rs 1,500, its financial statements would show net income of Rs 2,500. Under the subtraction method, its tax base would be Rs18,000 – Rs 14,000 = Rs 4,000. Under the addition method, its tax base would also be Rs 4,000 (wages of Rs 1,500 + owner profit of Rs 2,500).